Long-run terms of trade for commodities

What could be the explanation of the relatively poor price performance of manufactures exports into which Australia has rapidly diversified since the late 1980s (when the $A was floated)? The RBA shows that in the period 1974 – 2004, Australian manufactured exports achieved a yearly 3.0 percentgrowth, compared to a world average of 3.6 percent. All commodities (rural + mineral including coal) over that period of time achieved a 3.7 percent annual growth in prices (world commodity prices just 3.2 percent). My guess is that the poor average price performance of our manufactured exports is due to compositional effects. Manufactures exports are concentrated in items such as ‘transport equipment’ where Australia is now just one cog in a much larger global intra-industry trade and where the high level of compeition and supply from developing countries ensures slower than average price growth. Here is part of the conclusion of the RBA report. bq. Commodities have long constituted the majority of Australia’s exports, averaging 73 per cent by value over the past century. While there has been a diversification away from commodity exports, they still account for over half of goods exports. Given that the majority of imports have been manufactures, the Prebisch-Singer hypothesis of falling relative commodity prices suggests that there should be a negative trend in Australia’s terms of trade. But the trend is no more than −0.1 per cent per annum over the full sample. The trend appears to have changed at several times during the century, notably there was seemingly a stronger negative trend in the period 1955–1987, which has since largely been reversed. But statistical tests are not able to identify changes in the trend. The fact that Australia’s terms of trade declined by less than the decline in the ratio of world commodity prices to world manufactures prices is due to two factors. First, the commodities that Australia has traditionally exported experienced faster price growth than a broader basket of commodities. Second, the export base diversified toward commodities that experienced relatively faster price growth. Perhaps surprisingly, the growth in manufactures exports had little role in ameliorating the negative trend. Manufactures export prices have risen more slowly than those of commodities, at least over the past 30 years. Overall, the negative trend is so slight that it is economically insignificant. Of more significance is the fact that shocks to the terms of trade have become shorter-lived. I can’t resist including this graphic from the report. Note the plunge in wool after the Korean War boom. The drop was compounded by the much more rapid growth in the volume of other commodities which grew 15-fold after the mid 1950s, while wool only doubled it’s volume.

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